Welcome to RBC’s Markets in Motion podcast, recorded May 23rd, 2022. I’m Lori Calvasina, Head of US Equity Strategy at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers.
This week in the podcast, we run through our takeaways from the first quarter 13fs of more than 300 of the biggest US based hedge funds, which came out last week. Three big things you need to know: First, our review of the performance trends and relative valuations of the most popular S&P 500 stocks in hedge funds suggests to us that the pandemic froth is out of these names, an important milestone, but on the valuation side there may still be some room to fall. Second, we are keeping a close eye on the performance trends of the most popular hedge fund stocks relative to the broader market as another gauge of institutional investor sentiment. Third, in terms of sector positioning, what jumps out to us the most is that while hedge fund positioning in Consumer Staples remained underweight relative to the Russell 3000 as 1Q22 came to an end, the underweight has narrowed and is back to its 3Q16 high – which we view as another cautious data point on the sector.
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Takeaway #1: Our work suggests that the pandemic froth is out of the most popular hedge fund stocks as both performance and valuations have been hit hard. Unfortunately, our work isn’t conclusive on the point of whether valuations have bottomed yet.
- We track two lists of the most popular stocks in more than 300 major hedge funds: the Hot Dogs (which captures the 20 most popular stocks in hedge funds based on the US dollar value owned) and the Hotels (which captures the 20 most popular stocks in hedge funds based on the percent of the companies market cap owned by hedge funds).
- Amid the recent volatility in the equity market, the performance and valuation trends of our baskets – relative to the broader market – have been hit quite hard and have reached some interesting levels relative to history.
- In the case of performance, the Hot Dogs have been sliding relative to the S&P 500, taking the relative ratio between our basket and the broader market index below its late 2018 lows. The Hotels have also been underperforming the broader market, and their relative performance trend is back to pre-pandemic levels where it is actually making an attempt to stabilize.
- The damage done to the valuations of these lists has been similar. For the Hot Dogs, the relative P/E multiple between the basket and the S&P 500 (based on median multiples for both) is back to its pre pandemic range. For the Hotels, the relative P/E multiple between the basket and the S&P 500 is also back to mid 2019 levels.
- All of this suggests to us that the froth injected into these names during the pandemic due to investors crowding into the same fundamental stories, excess liquidity from the Fed, and fiscal stimulus from DC is out of these stocks.
- That being said, when we look at these charts, it’s not entirely clear whether these baskets have necessarily found a floor. The Hot Dogs’ relative P/E is still above levels that marked lows seen in 2018, 2019, and 2020 and that the Hotels’ relative P/E is still above levels that marked its own lows in 2017-2018.
- If recession is avoided, the normalization we’ve seen already may end up being enough. But if recession risks continue to rise in the eyes of investors, we wouldn’t be entirely surprised to see valuations take another leg lower and revisit those past bottoms.
- Our bottom line – what we’re seeing is a positive data point for the broader market and the idea of institutional investor capitulation, but it’s not a table pounder.
Takeaway #2: We’ll be keeping a close eye on the Hot Dogs performance trends relative to the S&P 500 as another gauge of institutional investor sentiment.
- Better performance in popular hedge fund stocks relative to the S&P 500 would signal to us that hedge fund sentiment is on the mend.
- The reason why - back in 2018, the Hot Dogs began to outperform the broader market starting in late November, roughly a month before the S&P 500 found its low for the year.
Wrapping up with takeaway #3: Hedge funds ended the first quarter with Consumer Staples positioning that was back to 3Q-2016’s high.
- Taking into account their holdings in all Russell 3000 and S&P 500 stocks, as well as sector ETFs, we found that hedge funds as a group remained underweight Secular Growth oriented sectors as a whole and overweight on Cyclicals/Commodities and Defensives (ex REITs).
- Within the Defensive category, Utilities and REITs positioning ended 1Q22 a little less underweight than usual.
- Health Care overweights remained extremely high vs. other sectors and relative to history, but admittedly that overweight has been fading since peaking back in 1Q20.
- But the biggest thing that jumped out to us about defensive sector positioning is that while Consumer Staples remained an underweight as 1Q22 came to an end, the underweight had narrowed significantly and positioning was essentially back to the peak made in 3Q16, when the low vol trade that had become so popular in the industrial recession of 2015-2016 began to unwind.
- We see this as another reason to be cautious on the sector going forward despite rising recession risks.
- Defensive sector valuations as a whole have been near historical extremes relative to Secular Growth Consumer Staples valuations have also been near peak levels relative to the S&P 500.
- When we dig down by industry, Beverages positioning looks like it may be peaking, and Food & Staples Retail positioning has been near all-time highs, though Food Products positioning had some room to run.
That’s all for now. Thanks for listening. And be sure to check out our sister podcast, RBC’s Industries in Motion, for sector specific thoughts from RBC’s team of equity analysts.